Insurance in the Era of Climate Change

Episode 22 of The Green Investor Podcast from Investopedia (October 6, 2022)

Welcome to The Green Investor, powered by Investopedia. I'm Caleb Silver, the Editor-in-Chief of Investopedia, and your guide and fellow traveler on our journey into what it means to be a green investor today, and where this investing team is headed in the future. In this episode, insurance goes under the microscope in the wake of Hurricane Ian's destruction through Florida and the southeastern seaboard. Who pays, who doesn't, and what is the future for flood and natural disaster insurance in the era of climate change? We'll talk to an expert.

Let's do the news. CEOs are putting many of their ESG goals on hold, as they try to prepare their businesses for the fallout from a possible recession, according to a study conducted by KPMG. About half of CEOs surveyed said they are pausing or reconsidering their existing or planned ESG efforts in the next six months, according to the survey. Roughly a third have already done so. More than eight out of ten global CEOs anticipate a recession within the next 12 months, so says the survey.

Spending resources on ESG goals that aren't fully defined within regulatory frameworks is slipping down the list of priorities, especially as investor skepticism around environmental, social and governance priorities continues to grow. In a separate survey by, a London-based online broker, traders and investors aren't prioritizing ESG either. Of more than 1,800 customers asked, 52% of traders and investors said they never selected a stock or made a trade based on ESG factors. Almost half, or 46%, said they didn't know how to do so, and 12% said ESG investments were too expensive.

As gas prices in Europe continue to climb amid sanctions against Russian oil, European Union (EU) member states backed a compromise to use permits from the bloc's carbon market to help finance a shift away from Russian fossil fuels. Finance ministers gathering in Luxembourg approved a compromise plan drawn up by the Czech government—which holds the EU's rotating presidency—to free up to €20 billion or $19.8 billion of carbon allowances. About 75% will come from the bloc's innovation fund, with the rest made available from front-loaded auctions. The money from the emissions trading system comes alongside leftover loans from the bloc's recovery fund, which member states can now use to help boost renewables, and the fossil fuel infrastructure needed to rid the EU of its dependance on Russian energy.

The U.S. Federal Reserve has announced a pilot program that will assess six of the nation's largest banks' exposure to climate risk, as regulators push to ensure that large financial companies are resilient to emerging threats. Bank of America, Citigroup, Goldman Sachs, JPMorgan Chase, Morgan Stanley, and Wells Fargo will participate in the Climate Scenario Analysis program, the Fed said, noting that the plan is designed to enhance the ability of supervisors and firms to measure and manage climate related financial risks. The exercise is "exploratory in nature and does not have capital consequences," the Fed emphasized in its announcement. It added that the scenario analysis can assist firms and supervisors in understanding how climate-related financial risks may manifest and differ from historical experience.

The Bank of England has already run a similar exercise with its member banks. The pilot exercise will be launched in early 2023, and is expected to conclude around the end of the year. At the beginning of the exercise, the Federal Reserve Board will publish details of the climate, economic and financial variables that make up the climate scenario narratives. We'll be looking forward to seeing that list, for sure.

Meet Brian Schneider

Brian Schneider, Fitch Ratings

Brian Schneider is the Senior Director of Insurance at Fitch Ratings, a position he has held since 2000. Brian has also headed the firm's Global Reinsurance sector since 2011.

Prior to his current position, Brian worked as a manager at CNA Insurance from 1996 to 2000, and as an analyst at Coregis from 1992 to 1996. He graduated from DePaul University and earned a master's in Finance and Econometrics from the University of Chicago.

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Hurricane Ian ravaged Florida's west coast, claiming dozens of lives and costing tens of billions of dollars in economic losses from heavy rainfall, storm surge, and flooding. If you were a property homeowner in Florida and you were lucky enough to have coverage for flooding, you may be made whole on your losses. But who covers the insurance companies that have to pay out these losses, and why would any insurer want to offer coverage in areas that are prone to hurricanes, flooding, and other natural disasters? Fitch Ratings evaluates credit risk for companies across all sectors and countries, including insurance and reinsurance companies. Brian Schneider is the Senior Director of Insurance for Fitch, and he joins us this week on The Green Investor. Thanks for being with us.

Brian: "Thanks for having me."

Caleb: "Fitch came out recently with damage estimates for Hurricane Ian that put losses between $25 and $40 billion—that was last week, before the hurricane really made its way across the state. But the estimates could go even higher depending on the damage done through Florida and up through the Carolinas, Brian. First of all, how does your group come up with that number?"

Brian: "Basically, we look at the various insurance companies and reinsurance companies that we cover, sort-of looking at what their market share looks like, what the comparable storms are, from previous large storms. We also consult with the various modelers. So there's a handful of modelers that really have a lot of detailed data on the individual insurance policies, and they're able to come up with estimates based on a lot of sophisticated modeling. So it'll also come up with various estimates in the last few days as well. And interestingly, they upped their estimates from the initial look at what was coming through a few days ago, and some of their estimates are up near $60 billion at this time."

Caleb: "Yeah, I mean, the pictures alone are devastating. The loss of life, obviously, is terrible, and the loss of property—it just seems unfathomable when you look at some of those images and the things we're not even seeing right now. Describe for us the homeowner's insurance dynamic in Florida today. A lot of the major carriers don't operate there. Why not? And what is the situation right now in the state?"

Brian: "Yeah, that's very true, and that's been going on for quite a bit of time. A lot of the larger companies really got wiped out from some of the previous hurricanes that came through Florida, and it's just very difficult for them to be able to make a profit there long term. So even in years where there aren't big losses, which they really hasn't been anything that big over the last four or five years in Florida. Certainly we had Irma in 2017 and Michael in 2018, but really, the large losses are coming through for the catastrophes. But in those years that we didn't have losses, companies still aren't making money, because there's quite an issue with fraud and assignment-of-benefit concerns in Florida. So there's a lot of litigation that comes through and just makes it makes it difficult."

"One stat that I saw recently, if you look at the amount of litigation, Florida represented about 8% of all homeowner's claims in the U.S. back in 2019, but 76% of all litigation claims against insurers came from the state of Florida. So that comes from the NAIC, which regulates the insurance companies across the U.S. So it's really issues in litigation that they've tried to address in various legislation sessions over the last several years. But for one, it takes time for those adjustments to come through and to help the insurance market. But then, in a lot of ways, they haven't gone far enough to reduce the amount of litigation in the state itself."

Caleb: "Citizens' Insurance is one of the biggest insurers that operates out of there. It was estimating, pre-storm, that it's going to have to cover some 150,000 claims, that could go up to $3.7 billion losses just from wind damage alone. But a lot of property owners can't get flood insurance, right? They can't get catastrophic insurance, or national disaster insurance. How are they getting their mortgages underwritten? How does the system operate? So many people have moved to Florida. So many people have second homes there. Are people who just don't have insurance flying blind and waiting for disasters like this to keep happening?"

Brian: "Yeah, I mean, to the extent that they do have mortgages, they will need to have insurance for that. You know, there are individuals that go down there, maybe they have a second home, who don't have a mortgage so they're not required to buy insurance. They can be difficult to get insurance. Citizens is there to be able to provide that state-sponsored, last-resort type of insurance. But their coverage, sometimes, is not really up to a level that you would need it to, depending on the value of their home. They're not really meant to try to provide coverage for those types of homes. So there is a private market, a surplus-lines market that operates in Florida and does provide insurance for those. But it is very, very expensive to be able to do that. And it can be difficult to provide defined, consistent coverage for those types of homes."

"Other options are maybe more specific, as you mentioned, to flood—because that's really where there are concerns, where the losses can be such a big piece of the overall insurance losses. When we look at insurance losses, really, you don't think about flood too much from a private insurance standpoint, because the flood market is relatively small for private insurers. It's really all insured through the National Flood Insurance Program, the NFIP. And that is where there's not a huge amount of take-up with flood insurance. I saw that only about 13% statewide have have flood coverage, maybe a little bit higher in those areas that were affected by Ian. And it's just something that a lot of individuals just don't buy."


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Caleb: "In a recent report, your group says this disaster is a reinsurance event. Explain to our listeners what you mean by that. Who are these reinsurance companies, and how can they absorb losses? If we're really talking about $60 billion, how can a reinsurance company absorb that? We know Warren Buffett of Berkshire Hathaway—they own a very big reinsurance company. Swiss Re is a very big reinsurance company. But just simply explain the dynamic. How does it work? How do these costs get passed on, and ultimately, who pays?"

Brian: "Yeah, so there are several layers. You have the policyholders obviously—they buy policies from the insurance companies, but then the insurance companies don't want a huge accumulation of risk, although they're not a big player in the market. Look at companies like Allstate that do have losses in some of the areas. They have aggregation of catastrophe risk across the whole country, and they don't want to have to have the losses if there is a large event like we saw with Hurricane Ian. So what they'll do is they'll buy their own insurance from what are called reinsurers. So as you mentioned, some of the big ones being National Indemnity with Warren Buffett's company, Berkshire Hathaway. You mentioned Swiss Re. But in Munich, there's a lot of big European reinsurers that have quite a bit of capital, and they have the ability to be able to withstand these type of losses."

"But over time, investors in these reinsurance companies are going to have issues with having these claims year-in and year-out. So we've seen heightened catastrophe losses over the last five years or so. Essentially since since 2017, there's been quite a bit of a catastrophe losses. So I know they have to go and explain to their investors every year why their losses are above average. And it really has taken a toll on their stock price, and they're, for the most part, trading below book value in recent periods because of the concern that these catastrophes will continue in the future. We've seen periods in the past where natural disasters have been less frequent—and that's really how insurers are able to make money in the long term, knowing that there will be certain years with fewer catastrophes and natural disasters. During those years, they can make up for years with elevated risk, where they are paying extra claims and having underwriting losses."

"One other layer that's actually on top of that, that impacts both of the layers beneath it, is what the industry calls retrocession, which occurs when the reinsurance companies go and buy insurance for themselves as well. So that's a smaller, more niche market. But a lot of these entities that insure the insurer—the reinsurance companies—are really the capital markets. So you'll have various insurance-linked securities that investors—certain more private investors, high-net worth individuals, will get involved in to provide that capacity to the reinsurers, to the extent that these reinsurers don't want to have as much risk either. And that's another area where we've seen a lot of price increases, we've seen a lot of capacity decline in the retrocession, or what we call the retro market."

"So if the reinsurance companies are unable to transfer risk to the retro market, and the insurance companies are seeing less ability to transfer risk to the reinsurance companies that don't want to have the extra claims, it really all flows down to the ultimate policyholders. So at the end of the day, the policyholder is the one that ultimately has to come up with whatever the losses are for any particular area, because that's really how insurance works—trying to spread the risk across a wide range, so that any one individual will not be devastated by that risk."

"But the problem is, with the geography of Florida, it's in a pass of hurricanes. And to the extent that we don't have these quiet periods where both the insurance companies and the reinsurance companies can build up profits and capital during periods of low activity—if we don't have those anymore, then it just makes it very, very difficult for the market to be able to work. Because if you're having high losses every year, then it just becomes very difficult to be able to afford the insurance premiums for these policyholders, and it simply becomes an affordability issue."

"And that's where the government gets involved, where they obviously want to have people living in Florida, they want to people coming to Florida. And to the extent that the insurance is just too expensive for that, which may just be the nature of the accumulation of losses that are just going to require high insurance premiums. And I talked a little bit about the potential for fraud, but I think in the long term, the amount of catastrophes that we're going to see in Florida, and the potentially other areas that we've seen in other parts of the world, just makes it that much more difficult to be able to insure that."

Caleb: "You're leading right into my question, which is: as climate change contributes to more and more deadly and costly disasters, what does that mean for insurance companies, their credit risk, and the exposure to investors? This is what you do at Fitch Ratings. You're looking at that risk; you're rating these companies. And I know you don't rate a lot of the companies that are in Florida, because a lot of the companies aren't in Florida. But this is going to be a nationwide and planetary thing. So how does Fitch even think about this in the in the era of climate change?"

Brian: "Yeah. So we talk to all the insurance and reinsurance companies that we rate. They provide us with detailed data, that they get from the various modelers that I was talking about. So we have an idea of what type of exposure that they may have to catastrophes in any given year—that has definitely increased over the last several years. A lot of what they've been doing though, in recent times, has been managing those numbers down. They're just writing less business in catastrophe-type areas, and we've seen increases in what they call "secondary perils." So the events that tend to get the big headlines are, you know, the hurricanes and the earthquakes and things like that."

"But in recent years, we've seen a lot more exposure from, say, wildfires. You know, we had the Texas winter storm last year—that was just a very unusual event. So we're getting more of these secondary, what they call secondary-type perils that maybe are not as big on the radar screen of the modeler. So those are the types of things that are causing more concern. And to the extent that climate change is impacting these, it's likely to only increase, so, fortunately, the companies are able to really manage their business, to be able to reduce the level of property risk that they have. A lot of these companies have maybe shifted away from property and more into, say, a casualty and specialty-type business which doesn't have that property-type risk exposure."

"So I guess the good news is that these insurance companies can can really manage that risk down, to a certain extent. They're able to to raise prices, and they have raised prices over the last several years. And at least at this point, they've been able to raise prices to a level—and I'm talking more nationally—Florida is a more specific issue—but nationally, these companies have been able to raise prices faster than the claims costs have increased. But you would expect that maybe after a certain amount of time, that there'll be rate fatigue for some of the other businesses and homeowners that are buying policies, and could run into issues where the competitive environment won't allow additional rate increases."

Caleb: "What's the worst-case scenario you're modeling for, as it relates to climate and natural disaster-related issues at Fitch Ratings?"

Brian: "If we kind-of look at where the catastrophe losses have come through, you know, we're averaging over $100 billion each year over the last five years. It was up as high as $150 billion back in 2017—that's when we had Hurricanes Harvey, Irma and Maria coming through. Each one of those generated losses of over $30 billion. As far as the extreme events—those get a bit more difficult to really be precise about when we look at our analysis."

"Within Fitch, what we do is we actually look across the entire curve of events that companies provide us with. So, all the way from an annual-type event to say, you know, a once-every-250 years type of event. So it's going to vary by company as to how they're able to withstand that. We think the industry is capable of withstanding, say, up to a one-in-100 year model type of a loss event. Beyond that, would have to be a likely capital-raising event for the industry."

"The bad news is, as large as these losses have been over the last several years, they're probably considered to be more of, you know, maybe a one-in-five, one-in-ten year type of event. So there could be a significant event that is more of a true one-in-100 year event. And there are various mechanisms that we've talked about, where companies can manage that through reinsurance and other types of economic management tools. But it's something that, you know, could potentially happen. And I think companies are in a fairly good position to be able to absorb those things."

"It's really more these unknown-type of events that can hurt these insurance companies, and cause the industry more pain. You know, are there going to be more events like we saw with the deep freeze in the South last year, are there going to be more wildfires? Those are the type of things that are not necessarily being priced into the market now, so continuation of additional catastrophe losses is a real possibility. And companies are trying to respond to that by increasing rates to be able to capture that. But at some point, it may be difficult to increase rates much more."

Caleb: "Well, let's see if we get any more of those one-in-100 type events, but it feels like they're coming more and more frequently. We appreciate your analysis and your insight. Bryan Schneider, the Senior Director for Insurance for Fitch Ratings, thanks so much for joining the Green Investor."

Brian: "Thank you for having me."

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